With just a little over six weeks left in 2018, investors will likely look back and proclaim this the "Year of Cannabis." So far this year we've witnessed Canada become the first industrialized country in the world to legalize recreational marijuana, and observed two additional U.S. states approve medical cannabis in midterm elections less than two weeks ago.
Beyond just legalization, the U.S. Food and Drug Administration approved its very first cannabis-derived drug, and we've seen no shortage of Canadian-listed pot stocks making the move from the over-the-counter exchange to reputable U.S. exchanges (i.e., the Nasdaq and New York Stock Exchange).
January could be a terrible month for marijuana stocks
With so many milestones hit this year and over the past couple of years, it's not been hard for investors to get behind marijuana stocks. Some of the top performers in the industry have seen gains that have easily surpassed 1,500% since the beginning of 2016. But as the old adage goes: "What goes up, must come down."
Generally speaking, high-quality stocks tend to increase in value over time, but that doesn't mean there aren't hiccups now and then. The upcoming month of January may turn out to be an awful month for marijuana stocks for two reasons in particular.
1. Tax-based profit-taking
To begin with, marijuana stock investors have had an incredible run over the past couple of years. Whereas December is typically known for its tax-loss selling -- i.e., investors dumping money-losing positions to potentially offset some of their capital gains and/or income for tax purposes -- January might be known for its profit-taking.
Here's the scenario: Marijuana stock investors who are up big on their positions, and who want to lock in some or all of those gains just in case the bubble does burst, could choose to sell prior to Dec. 31, 2018, and owe capital gains tax on or before the April 15, 2019, tax deadline. The other, generally more favorable, option is to sell after the calendar changes to 2019. Any capital gains registered in 2019 won't come due until as late as Tax Day 2020, which would be up to 15 1/2 months away, without an extension. I suspect that'll be enticing for both short- and long-term traders.
The downside is that if this tax-based selling comes to fruition, it could seriously weigh on the industry. Interestingly, January 2018 is when we saw marijuana stocks begin what would become a six-month slide earlier this year, before they rallied to new highs in the third quarter. Will January 2019 offer a repeat? We shall soon find out.
2. Tilray's IPO lock-up period
A lock-up period describes a predetermined amount of time (in this case, 180 days) following an initial public offering (IPO) where company insiders are contractually barred from selling their shares. Since going public at $17 per share in late July, Tilray's stock has blasted as high as $300 on an intraday basis. Even with its stock off significantly from that all-time high, shares of the medical cannabis grower are still trading north of $110. That's an enticing proposition that could encourage some of the company's insiders to lock in their gains, which, presumably, would send Tilray's share price lower.
The bigger issue here is that Tilray is arguably being viewed as a foundation for cannabis stocks. Its rapid ascent has investors dreaming of triple- and quadruple-digit returns as they search for the next Tilray. But if Tilray somehow proves fallible following its lock-up period, it has the potential to weigh on investor sentiment and send folks scurrying to the exit.
Regardless of what happens in January, think of the big picture
However, no matter what happens this coming January, it's important that pot stock investors remain focused on the long run. Remember, there's virtually no precedence to legalizing recreational cannabis, so Wall Street analysts are learning right alongside retail investors how these stocks should be properly valued. That's a recipe for wild fluctuations in marijuana stock prices from time to time.
With Canada having legalized recreational weed and 32 U.S. states authorizing medical cannabis sales, it's pretty clear that marijuana is a viable business model. This means there will be winners that emerge. What we don't yet know is which companies will stand out as leaders, and it's going to take time to figure this out. This means investors need to have patience and allow the industry to mature before they ultimately pass judgment on marijuana stocks.